Guhan Subramanian is Joseph H. Flom Professor of Law and Business at Harvard Law School and H. Douglas Weaver Professor of Business Law at Harvard Business School and Annie Zhao is a Fellow in the Program for Research on Markets and Organizations at Harvard Business School. This post is based on their recent paper.

Until approximately 2005, the traditional sale process for U.S. public companies involved a broad market canvass and a merger agreement with the winning bidder, followed by a “no shop” obligation for the seller between the signing and the closing of the merger. In the mid-2000s, however, the introduction of the “go-shop” technology turned this standard deal template on its head. In its purest form, a go-shop process involves an exclusive (or nearly exclusive) negotiation with a single buyer, followed by an extensive post-signing “go shop” process to see if a higher bidder could be found.

The first go-shop transaction appeared in Welsh, Carson, Anderson & Stowe’s buyout of U.S. Oncology in March 2004. Go-shops proliferated quickly after that, particularly in private equity (PE) buyouts of public companies. Many commentators at the time were skeptical of go-shops. The conventional wisdom held that go-shops amounted to nothing more than a fig leaf to provide cover for management to seal the deal with its preferred bidder, while insulating the board against claims that it failed to satisfy its obligation to maximize value for the shareholders in the sale of the company.

A decade ago, one of us published Go-Shops vs. No-Shops in Private Equity Deals: Evidence & Implications, the first systematic empirical assessment of go-shops (the “Original Study”). The sample included all PE buyouts announced between January 2006 and August 2007 (n=141), including 48 deals that involved go-shop processes. In contrast to practitioner and academic commentary at the time that was generally skeptical of go-shops, the Original Study found that go-shops frequently led to higher bidders during the go-shop period, and that sellers extracted slightly higher prices from the original bidder in exchange for pre-signing exclusivity. Subsequent studies have generally confirmed these empirical findings.

Today, go-shops are a common tool for PE buyouts of public companies. In view of the earlier empirical findings and the general view today that go-shops can be meaningful, the continued deployment of go-shops might be viewed as a positive development in the evolution of public-company mergers & acquisitions (M&A). However, we present new evidence suggesting that go-shops have become less effective as a tool for price discovery since the timeframe of our earlier empirical analysis. The Original Study, which examined deals announced in 2006-07, reported that a higher bid emerged during the go-shop period 12.5% of the time (6 instances out of 48 go-shop deals). Using a new database of M&A transactions over the past nine years, we find that the jump rate in the 2010-2018 timeframe was 5.6% (6 out of 108 go-shops), declining to 2.5% (1 out of 40) in the period 2015-2018. The last successful go-shop in our sample occurred approximately three years ago, in January 2016, when II-VI Inc. successfully jumped GaAs Labs’ offer for ANADIGICS, Inc. during a 25-day go-shop period.

This decline in jump rates cannot be explained by straightforward factors, such as uniformly shorter go-shop periods, an increase in go-shop termination fees, or a tightening of Excluded Party definitions. Delaware courts have emphasized the importance of these factors for structuring a meaningful go-shop process, and practitioners, not surprisingly, have taken that guidance. As with other areas of transactional practice, the lawyers, bankers, and principals are far better than that in burying their handiwork. The real explanation requires deeper digging into structural and contextual factors involving go-shops.

Match rights, for example, which were just beginning to appear at the time of the Original Study, are now ubiquitous. Basic game theory indicates that match rights will deter prospective third-party bidders. Go-shop windows are no longer as sensitive to deal size as they were in the Original Study. The result is shorter go-shop windows in larger deals, which amplifies information asymmetries and “winner’s curse” concerns. Shorter go-shop windows also make consortium bids more difficult, which are particularly important for larger deals. These developments reduce the effectiveness of go-shops as a tool for price discovery.

Conflicts of interest for management also hinder the effectiveness of go-shop processes. CEO’s often have a financial incentive to keep the deal price down, which means discouraging potential third-party bids during the go-shop process. And in some instances, CEOs have undisclosed qualitative reasons for discouraging third-party bids.

Conflicts of interest among the investment bankers can also reduce the effectiveness of go-shops. For example, in the incestuous world of private equity, the sell-side banker’s financial incentives to please the buyer (who does not want an overbid) may be larger than the banker’s financial incentives to find a higher bidder during the go-shop period. Alternatively, or in addition, the buyer’s bankers may discourage prospective buyers from meaningful participation in the go-shop process. Our paper presents a taxonomy of these conflicts and provides examples of each. It also documents how boards fail to form special committees that might adequately cleanse these conflicts.

A final category of reasons that can reduce the effectiveness of the go-shop process involves the technical details of the go-shop itself. Through a complex interaction of deal terms, some buyers have achieved a “back door” tightening of the “Superior Proposal” and “Excluded Party” definitions, so as to effectively require potential third-party buyers to make a full-blown acquisition proposal during the go-shop period. These seemingly technical adjustments to the legal terms of go-shop can significantly reduce the effectiveness of the go-shop as a tool for price discovery.

At the highest level, the story of the go-shop technology over the past ten years is one of innovation corrupted: transactional planners innovate, the Delaware courts signal qualified acceptance, and then a broader set of practitioners push the technology beyond its breaking point. This trajectory has a venerable pedigree. Mortgage securitization unquestionably created enormous value for society in the 1970s and 1980s, but practitioners pushed this technology too far by the 2000s, leading to the financial crisis of 2008-2009. Likewise the proliferation of derivatives unquestionably created enormous value in the 1980s and 1990s, but the distortion and eventual corruption of this new technology led to the Enron debacle of 2003. In view of this (no doubt) eternal dance between practitioners and their regulators, our paper concludes with specific recommendations for the Delaware courts and transactional planners in the realm of go-shop processes.

At stake are general policy goals involving allocational efficiency in the M&A marketplace. Economists generally agree that social welfare is maximized when assets flow to their highest and best use; while lawyers, bankers, and principals on the buy-side (and sometimes on the sell-side) want to maximize deal certainty rather than allocational efficiency. Corporate law must therefore police the deal process to ensure that business objectives and professional interests do not crowd out desirable policy goals. Go-shops can facilitate allocational efficiency if (but only if) they are structured properly. Our paper presents evidence that the go-shop deal technology has moved away from fulfilling its potential as a tool for allocational efficiency over the past ten years. It also proposes specific interventions for practitioners and courts to set things back on course.